The 'Bond Vigilante vs. Fed' Mantra Makes No Sense

NEW YORK (TheStreet) -- There is a new macroeconomic mantra that has spread itself across themarkets and on CNBC in the last couple of months in particular. Itgoes something like this:

1. The U.S. Treasury issues $1.3 trillion per year in deficit financing;

2. The Federal Reserve buys over 80% of the deficit -- $85 billion per month;

3. The "Bond Vigilantes" are dead because the Fed buys essentiallyall the bonds;

4. There is no inflation, and interest rates will stay low foreversimply because the Fed has unlimited buying power;

5. Downgrading U.S. government debt by rating agencies don't matter,because after they did it last time (August 2011) interest rates onlywent down.

Turn on CNBC and you will hear some minor version of this "newreality" more times per day than you can count. Listening to thisyou could be excused for thinking there is no reason toworry, ever. Deficits don't matter, and interest rates can neverrise.

Here is what you have to ask yourself: If it's this easy, why doesn'teveryone do it all the time?

What we have in the U.S. right now is massive, painless governmentspending: The government essentially spends whatever it wants,because its compliant Federal Reserve simply prints up the differencebetween tax revenue and spending.

As you can see from this data series, cumulative federalspending was $28 trillion over the last 10 years. For the next 10years, the most conservative outlook is $46 trillion, a 65% increaseover the previous 10 years.

Back to the central question: If it's this easy, why doesn't everyone do it?

The cost of this policy appears to be nothing, zero:
  • No inflation
  • No high interest rates
  • No economic collapse
  • No need to cut any government program, ever
  • No currency crisis

It's all sweetness, light and jingles. Candy all the way, no hardwork, no saving, no deferral of spending, no pain, no problem.

Let's cut a few decimal points off this Federal government equation toshow what it would mean for an individual. You make $250,000 peryear, you spend $380,000, you borrow $30,000 and you go to yourbasement printing press for $100,000 in $20 bills to pay for your drughabit.

Anything wrong with this picture?

We are being told there is no penalty for this policy. We areimmune to any need to cut our excessive spending habit because canprint almost all of the deficit. There is, therefore, no price to pay.

Why even bother discussing austerity programs, whether in Greece,Spain, Italy, Portugal or right here in the U.S.? If the U.S. can be justfine simply printing almost its entire deficit, why can't Europe dothe same? If there truly is no cost to doing this, why hold back?

It's, like, "Why didn't anyone think of this before?"

The bond vigilantes have been neutered, we are told, because the Fedsimply assumed unlimited powers. So it is therefore metaphysicallyimpossible for interest rates to rise. If the Fed just buys all debt,then interest rates will be as low as the Fed wants forever, right?

Throughout history, all sorts of countries have been forced to cutback on spending when the basic forces of financial gravity have setin. You have to cut the budget in various places until you don'tspend more than you take in. Just ask the Greeks right now.

Looking at the U.S. situation right now, why aren't all of these othercountries asking themselves: Why don't we just establish a Fed aswell, and then we can increase spending infinitely and simply haveour own central bank buy all the debt? No pain, no problem.

Standard economic theory for centuries tells us this policygenerates massive inflation, currency devaluation, rapidly risinginterest rates. We need only go back to the 1970s right here in theU.S., and at that time the money-printing was a pittance compared totoday.

The Fed's inflationary policy, in order to "accommodate" the federalgovernment's spending binge -- 65% or more increase over 10 years --has come with zero economic penalty. Interest rates are down and weare constantly being told by our government that we have essentiallyzero inflation.

Some people would say the effects of this policy is only a matterof time. Some time! Given the magnitude, if it hasn't happenedalready, the "catch-up" impact when we have to pay for all of thisthrough higher interest rates would be as epic as the fall of Rome.

Just look at the data series of federal government spending:
  • 1996: $1.6 trillion
  • 2005: $2.5 trillion
  • 2009: $2.8 trillion
  • 2012: $3.8 trillion

Current (2012) tax revenue: $2.5 trillion. In other words, iffederal spending were just kept to the 2005 level -- which includedIraq, Hurricane Katrina, etc -- the federal budget would be in 100%balance, right now.

But why bother keeping a budget anywhere near a balance if it's freeto just spend an unlimited amount of money on top of it? The Fedbuying all the extra deficit spending is, after all, free, we aretold. No adverse impact on inflation, interest rates, the dollar oranything else. The price is not showing up in any column.

Small wonder Washington, D.C., has us increasing federal spending to anaverage of at least $4.6 trillion for each the next 10 years. If itdoesn't cost anything, why not? And why stop there? Why not $5trillion per year? $6 trillion? Hey, pick any number you want.

Bottom line: If we return to a world where the laws of economicgravity come back to reality, the crash will be epic and sudden. Isthere any way to protect yourself other than to buy GLD?

At the time of publication the author had a position in GLD.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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